CooTek (Cayman) Inc. American Depositary Shares, each representing 650 Class A Ordinary Shares

Good day, and welcome to CUTEC's third quarter 2020 unaudited financial results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Jessie Jin from Institutional Capital Advisory. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us today. Our earnings release was distributed earlier today and is available on our IR website at ir.cootech.com. and our PR Newswire. On the call today from QuTech are Mr. Carl Zhang, Chairman and Chief Technology Officer, and Mr. Robert Tsui, Chief Financial Officer. Mr. Zhang will review business operations and company highlights, followed by Mr. Tsui, who will discuss financials and guidance. They will both be available to answer your questions during the Q&A session that follows. Before we begin, I'd like to kindly remind you that this conference contains forward-looking statements within the meaning of Section 21 of the Securities Exchange Act of 1934 as amended. These forward-looking statements are made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminology such as will, expect, anticipate, future, intense, sense, leave, estimate, confident, and similar statements. COTEC may also make regional or oral forward-looking statements in its report filed with or furnished to the USSEC in its annual report to shareholders in press releases and other written materials and oral statements made by its officers directors, or employees to third parties. Any statements that are not historical facts, including statements about full-text beliefs and expectations, are forward-looking statements that involve factors, risks, and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such factors and risks include, but are not limited to, the following. Full-text missions and strategies future business development, financial conditions and results of operations, the excessive growth of the mobile internet industry and the mobile advertising industry, the excessive growth of mobile advertising, expectations regarding demand for and market acceptance of the company's products and services, competition in the mobile application and advertising industry, and relevant government policies and regulations relating to the industry. Further information regarding this and other risks, uncertainties, and factors is included in the company's findings with the U.S. SEC. All information provided on this call is current as of the date of this call, and Q-TECH does not undertake any obligation to update such information except as required under law. It is now my pleasure to introduce Mr. Carl Jung. Carl, please go ahead.

Thank you. Thank you, everyone, for joining our third quarter. 2020 earnings call. We are excited to report our third quarter performance, where we recorded high year-over-year growth. Total net revenue for the quarter grew 238% year-over-year to $106 million. Driven by the strategic enhancement of our company's ecosystem, we further upgraded and strengthened our core products aiming at delivering the sustainable business growth. Our online literature business achieved its critical milestone this quarter. I'd like to take this opportunity to thank our team for an incredible job. With its daily active users, DAU in brief, exceeding 10 million, and monthly active users, MAUs in brief, close to 30 million during the third quarter of 2020. Songdo Novel constituted the core component of our content-rich portfolio with a strong emphasis on balancing its user expansion and long-term user retention by enlarging its customized content resources and introducing multiple functions of its interactive community. We consolidated the market position of Fengdu Novel, which ranked number three in terms of MAUs in free online literature market in China, with continuous growth in our user base. We believe that online literature is an enormous market globally, and we have been focusing on building up long-term value. So this quarter, our great effort on improving both user thickness and content ecosystems achieved significant results. The average daily reading time per daily active reading user of Fengdu novel increased from 110 minutes in June to approximately 130 minutes in September. The 30-day and the 60-day user retention rate also increased by about 4% and about 3% respectively, compared to June 2020. The user engagement ratio of Fengdu novel increased from 29% in June to 34% in September. So our strong growth is attachment to the user thickness of Fengdu community and its huge potential. We are also dedicated to further cultivate our content ecosystem by increasing the number of signed writers, which grew to over 2,000 in October. Most of them are very active on our literature platform. The books produced by our signed writers contributed more than 50% of total content consumption, both in terms of time span and revenue. Our philosophy is to build a customized content protection model that establishes the data feedback and metrics between our writers and our users so that the content ecosystem is adapted to users' ever-evolving content needs. We developed an AI and data-driven system to enable our writers to produce more suitable content for our users. and continuously adapt to changing demands based on data feedback. The platform that we're building is not just a place for writers to publish books, but also a platform to really enable them to improve their ads based on proper data metrics so that even an average writer could possibly write books that will perform well from data perspective and generate more revenue accordingly. And we are also expanding cooperation with other third-party IP and the literature resource platforms to increase our book inventory. In addition, we are dedicated to further increase the scale and the depth of our content resource by further increasing the investment in our content ecosystem. All these results validated the accessibility and the long-term value of our online literature business. I'm very confident that Fundo Novel can remain as one of the top players in the free online literature market with strong potential to further upgrade the market position. At the same time, we have been accumulating the growth momentum for our overseas online literature product, which rested one of the top apps in the book app category in the U.S. market. The 30-day user retention rate and average user reading time both recorded new highs in the third quarter, respectively. The high user thickness made us believe that it is a very strong opportunity for further improving our competitive edge in the online literature sector globally. Coming back to our overall business update, Our mission is to empower everyone to enjoy relevant content efficiency. We have focused our content ad strategy in three categories, online literature, scenario-based content ads, and mobile games. In terms of user base, total DAUs and MAUs for our content-rich portfolio products were 37.7 million and 94.8 million in September this year. as approximately 16% and 40% year-over-year, respectively, mainly due to the increase in DAUs and MAUs of our online literature and overseas casual game products. We believe that the user data is a key performance indicator of our online literature business, but not the most reliable performance indicator of our scenario-based apps and mobile game business. considering the high number of products with different product cycle and Apple level in different countries and regions. We decided not to report separately the user data for the scenario-based apps and the mobile casual game business going forward. Since we realized the mobile casual game is one of the key business segments which we can prove the strong synergy in growing simultaneously with our online literature business in terms of user base and IP layers. We have continued to invest meaningfully since the fourth quarter of last year. Although our game products still reflected profitability, we observed the typical volatility in relation to the revenue and ROI performance of certain mobile casual game products closing to the end of their lifetime cycle. which results in the fluctuation compared to the second quarter of 2020. So we are going to release more competing casual games to form the foundation of our game business. And we will gradually reduce the proportion of highly casual game types with shorter product cycles to reduce the impact of revenue and net profits for the group. And we will further strengthen the development of MIP core games so that the business can serve as a stable source of revenue and net profit for the group. I'm convinced that the execution capability of our team can contribute to the strategy upgrade and growth remediation. Our scenario-based apps remain one of the stable revenues and the net profit contributors since our IPO. We have successfully streamlined the product mix for key focus on user-oriented products with selected vertical areas, such as sports and fitness. We will further upgrade the function of the product while ensuring the positive ROI level. It is expected that the scenario-based apps will continuously serve as sustainable growth driver for the revenue and net profit of the group with reasonable growth. If I have to use one word to describe our year-to-day performance, it is resilient. Our business development since 2019 shows that we are not afraid to make big changes for the long-term success of our business. We continue to grow and apply our AI and big data technologies to provide the content products to our users. We built a solid foundation around the global online literature ecosystem. We became one of the leading online reading apps in China. At the same time, our global content rich apps are experiencing robust growth. We have been very excited to deliver our visual plan for user growth. content enhancements, and technology upgrades. There will be continuous and proven growth in the business and the financial performance growth of the group in the next one or two years. In addition, the quality and the sustainability of the revenue growth will continue to improve. I have never felt more optimistic about the future of QuTech than we do today. We would like to also take this opportunity to thank all our investors who stayed with us. With that, I will hand the call to Thierry Paul Roberts, who will walk you through our financial results for the quarter. Thank you.

Thanks, Carl. Hello, everyone. Thanks again for joining us tonight. Despite the growth pressure in global mobile internet advertising markets, The group's net revenues during the third quarter of 2020 was still up 238% year-over-year to $106 million. The net revenues are mainly generated from three categories of our content-rich apps, online literature, scenario-based content apps, and title games. For online literature, which was launched in 2019, it already constituted 34% of our total revenue in the third quarter of 2020. As mentioned, MAUs reached 29.5 million in September 2020, and average DEUs already exceeded 10 million in September 2020. That is a very significant increase from a year ago. It's stably ranked, Fengdu Novo, the core product, stably ranked one of the top three players in terms of MAUs for free online literature products, according to Quest Mobile in the Chinese market. We have been seeing the rapid growth of the user base of the product, and we are expecting a continued growth in the coming years. Casual games and scenario-based content apps accounted for about 41% and 24% of total revenue in the third quarter of 2020, respectively. They continue to generate considerable revenue and stable profits to our business. Now turning to expenses. Gap costs and expenses were about $128 million, up 3% sequentially, and up 168% year-over-year. Non-gap costs and expenses were $126 million, up 3% sequentially, and up 170% year-over-year. As a percentage of revenue, non-gap costs and expenses accounted for 119%, up from 97% in the second quarter. 2020. Sales and marketing expenses increased by 222% from the same period last year and 2% sequentially. The largest component of these expenses is the user acquisition costs. As we continue to execute on our content-rich portfolio strategy, we need to keep investing to expand the user basis of these portfolio products and cultivate our content ecosystem. R&D expenses increased by 18%. year-over-year and by 1% sequentially, primarily due to an increase in costs associated with technology R&D staff and share-based compensation expenses. We ended the quarter with 720 full-time employees, up 40% year-over-year. R&D employees represent about 60% of our total employees, compared with 63% last year. G&A expenses decreased by 10% sequentially, and increased by 9% compared with the same period last year. The sequential decrease was mainly due to the reversal of accrued provision for bad debts on the collection of accounts receivables. The year-over-year increase was mainly due to an increase in costs associated with G&A staff and share-based compensation expenses. G&A expenses as a percentage to total net revenue were 4% from 3% last quarter. we are keeping expenses under control. Growth margin was 93%, 93.6%, up from 87.5% during the same period last year, and a slight decrease from 95.5% last quarter. The increases are mainly due to greater economics, economies of scale, as we better utilize our infrastructure, and partially offset by the increase in content costs. Gap net loss was 22%. million U.S., excluding the effects of stock compensation, adjusted net loss was approximately 20.5 million U.S. As of September 30, 2020, we had cash, cash equivalents, and restricted cash of about 61 million U.S. dollars, compared with 60 million U.S. dollars at the end of year 2019. Net cash outflow from operating activities during the quarter of 2020 was 14.4 million US, mainly due to loss from operations. On May the 18th, 2020, we launched a new share repurchase program where we are authorized to repurchase up to 20 million US of our PDS during the 12-month period starting from May the 18th, 2020. As of September 2020, we had used an aggregate of 3.3 million US to repurchase 0.5 million ADS. Turning now to our revenue outlook, we expect total revenue in the fourth quarter of 2020 to be around 106 million US, representing an increase of around 54% year-over-year. For the full year of 2020, we expect total revenue to be around 445 million US, representing an increase of around 150% year-over-year. These estimates reflect our current and preliminary view, which is subject to change. Operator, we are now ready to take questions.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. Once again, it is star then one to ask a question. At this time, we will pause momentarily to assemble our roster. The first question comes from Hunter Diamond of Diamond Equity Research. Please go ahead.

Hi. Congratulations on the very strong quarter in this tough environment. So with the new lockdown, you know, returning at least in the U.S. in the fourth quarter, how do you anticipate the impact to the overall online ad budget affecting the platform in China and the global markets? And can you disclose roughly the amount of revenues brought by advertisers in China and then the overseas market?

Okay, I will take the first question. We have seen the broad pressure, obviously, in the online advertising market, both in Chinese and overseas regions. According to QuestMolar, the market size of the Chinese internet advertising market in 2020 is projected to be... 528 billion RMB with a year-on-year growth of 12.4%, which is lower actually than the year-on-year growth of 14.8% in 2019. Also, global internet advertising will remain flat with a small decline of 0.1% in 2020 as the overall global advertising market is expected to decline by at least 7.4% per OMDIA, a technology research company. But at the same time, we also witnessed some positive development, in particular in the Chinese market. On the internet advertising market side, it has restored growth since Q2 2020, despite the negative trend in the first quarter 2020 due to the coronavirus pandemic. As China is one of the few countries with good control of the pandemic, and the overall economy has resumed growth, we expect that the advertising markets will also gain growth regain growth momentum in 2021, which will be beneficial for supporting our business growth. In relation to our own platform, we have a similar observation in relation to the advertising inventory and eCPM. We believe that our content-driven model with high user spending time will still be very competitive for attracting relevant advertisers. For the overseas market, we remain more cautious. Given our current advertising revenue mainly comes from the Chinese market with a percentage more than 90%, we will also be more resilient to the growth pressure in the global internet advertising market.

Great. Thank you very much for the additional details. So my second question is the company obviously is targeting the global online literature markets. and plans to launch apps overseas. Can you just give us some color and details on the prospect of expanding overseas, how you expect that contributing to daily active users and top-line growth?

Well, I'll take this question.

So, yes, we have been incubating our online literature apps for global market, especially for English-speaking countries as the first step since early this year. So during the past couple of quarters, we have validated that our growth model and our philosophy of cultivating content ecosystem, which have been validated on Songdu Novel in China's domestic market, work pretty well in global market as well. So what's more, we found that the entire book publication industry is more traditional compared to the Chinese market. So we believe that by introducing AI and the data-driven technology and philosophy to cultivate the content ecosystem, we have the opportunity to reshape the industry globally. And we have attracted a lot of U.S. local writers and signed a lot of English native books. And the community has formed. At the same time, we have been accumulating the growth momentum for our overseas online literature products, which ranked as one of the top apps in the book category at ranking in US market on both App Store and Google Play. And the 30 days user retention rate and average user reading time both recorded new high in the third quarter, respectively. The average output of our online literature app in the U.S. market is higher than Fengdu in the Chinese market. The high user thickness made us believe that it is a very strong opportunity for further improving our competitive edge in the online literature sector globally. And now we are tweaking its ROI and considering the long-term and the potential to bring in multiple monetization models, we think that global markets deserve more investment in both short-term and long-term. Thank you.

Great. Thank you for taking the questions and the additional details, and a grand congratulations on the strong quarter.

Thank you. Thank you.

And the next question comes from Chen Jingguang of Haitong. Please go ahead. 感谢领导的分享。 我这边主要是看A股的分析师, 我是海上中心的传媒研究员陈静光。 我对公司之前的发展也是比较关注的。 我这边主要有三个问题想要管理层请教一下。 第一个问题是,

The company's product has been growing relatively well. I would like to ask, what are the advantages and disadvantages of our product compared to the first-tier products? The second question is, we can see that some of the internal network controls are gradually being delayed in recent years. Our product is mainly recommended and promoted through algorithm. In the future, what methods can we use to review the content in this regard? OK.

I'll briefly translate the questions from Python. The first question is regarding the growth strategy and competitive edge between Fengdu and Toutiao. What are the advantages of Fengdu that you would like to elaborate? The second question is regarding the regulations in Chinese markets. Regarding your AI strategy and there have been some technological issues, strategies within your core product, how would you like to work around the regulations and to further improve the growth? And the third question is regarding the future, the outlook and further future positioning of your online game products, casual game products, correction.

Okay, so I'm going to take all of the three questions. The first question is about the competency of our Songdo novel and how we compete with our competitors. So, you know, I'm not in the right position to comment or judge our competitors, but we believe that we have different growth philosophy and point of view on this market. So at this stage, we are maintaining first-tier user retention rate among all the competitors. That is The user-sickness of Fondue Novel is competitive and I think very strong. So for long-term, as it is a typical content app, we are actually spending a lot of our effort to cultivate our differentiated writer ecosystem. Our philosophy is to build a customized content protection model that establish the data feedback and metrics between our writers and readers so that the content ecosystem is adaptive to users every evolving content need. For example, when we established our ecosystem, we think more about how to enable our assigned writers with AI-enabled data platform and metrics. And the platform that we are building is not just a place for writers to publish books. but also a platform to really enable them to improve their ads based on proper data metrics so that even an average writer could possibly write books that will perform well from data perspective and generate more revenue accordingly. Instead of focusing on quantity of our books, we focus more on quality. The books produced by our signed writers contributed more than 50% of total content consumption, both in terms of time spent and revenue. And online literature is an enormous market globally, and such kind of market has never been dominated by any single player, simply because of users' diverse and ever-evolving content needs, and the existing huge writer base. So we are confident to sustain the growth momentum in China market and at the same time explore the global opportunity. And the second question is about the regulation. So it is a good question. So I think to make our online literature business sound and sustainable, it's very important to comply with evolving regulations. To ensure this, we established and added a team, and at the same time, we introduced technology solutions to review and filter our content from the very beginning. And thanks to our customized content production model, it is much easier for us to ensure the compliance of our content because we control the entire ecosystem. And the third question is about the game business. So we launched our first mobile casual game in the fourth quarter of last year. So as I mentioned, the mobile game business has very strong synergy with online literature business in terms of user base and IP layer. So thanks to the rapid growth of our online literature business, our mobile game business has benefited and achieved significant growth in this year. But anyway, our mobile game business has only one year history, so it is still in its early stage. Although our game products still reflected profitability, we observed the typical volatility in relation to the revenue and ROI performance of certain mobile casual game products closing to the end of their lifetime cycle, which results in the fluctuation compared to the second quarter of 2020. And firstly, we will expand our success on casual games by developing and releasing more competing casual games to form the foundation of our game business, so as to reduce the impact of revenue and net profit for the group. And secondly, we are incubating some new concepts of casual games, which have relatively longer lifetimes and improved user-sickness. At the same time, we will further strengthen the development of mid-core games so that the business can serve as a stable source of revenue and net profit for the group. Thank you.

And was there a follow-up, Mr. Jingguang? Okay, we'll go to the next question. That is from Nelson Truong from Citi. Please go ahead.

Hi, management. Thank you for taking my question. This is Nelson Truong from Citi asking on behalf of Alicia two questions. First, regarding your guidance, could you elaborate more on the flat-ish revenue guidance implied for fourth quarter? Is that mainly due to seasonality or weakness in gaming or Novo? And what should we think about first quarter 2021 trend and overall 2021 outlook? And my second question is on the selling and marketing spending, because it seems like this quarter the spending is a bit higher than expected. Can you explain the reason behind it? Is it due to the user retention or the channel for user acquisition is not that effective? How should we think about the selling and marketing dollars in next quarter and going forward? Thank you.

Okay, thank you, Nelson. I will take these two questions. The first one regarding the revenue guidance. The revenue guidance for Q4 this year is reflecting mainly the restructuring of our game product portfolio, targeting at building a more balanced pipeline to avoid further volatility in relation to the revenue, to the overall revenue. Even if we not have imminent effect for supporting our total revenue, we believe that the Q4 revenue will be flat compared to Q3 revenue. But at the same time, our online literature business will continue to grow in terms of user base and ARPU. So it will also have a larger revenue contribution in Q4 compared to Q3 as well. For the overall 2021 trend, we expect a continuously solid and high growth rate for our online literature business. The scenario-based content apps business will grow stably, and the casual game business will start to regain the growth momentum. So for the total revenue, we still forecast more than around 30% to 40% year-over-year growth in 2021 with the key growth driver of our online literature business. The second question regarding the sales and marketing expense. It is true that the sales and marketing expenses as a percentage of revenue in Q3 was higher than Q2, given our revenue slightly decreased compared to Q2. But actually, the exact number of the sales and marketing expense was pretty much the same. The user acquisition costs remained as the key component of the sales and marketing expense. In particular, the CPA in Q3 has been increasing due to the competition of online education and gaming products for the mobile internet traffic in the Chinese market. We do expect similar situation in Q4, but going forward, we expect that the sales and market expenses will decrease stably as a percentage of revenue in the coming quarters with our continued and increased investment in the content resources on our platform, which will help increase the user retention rates for our existing users and also the user acquisition efficiency for our new users. Thank you.

Thank you.

The next question comes from Aaron Zhu of Tigris Financial Partners. Please go ahead.

Hi, this is Aaron. Thank you, management team, for taking my question. So I have a question also regarding the Fondue Novo. The live in China is basically going to go back to normal, and we still see the DAU and the user reading time of Fondue Novo continue to grow very well sequentially post the COVID in China. So could you please elaborate what are the main reasons to drive this growth? And is there any guidance on the DAU ARP and retention rate for the next year on the Fondue Novo? Thank you.

Thank you, Aaron. I will take this question as well. In relation to the key reason of the continuous growth in our average daily reading time per active user in the third quarter, it is mainly due to our continuous enhancement and upgrade of our content resource within our platform because we continue to invest in this area by leveraging our core competency in the science writers platform and also by increasing the continuous input of our partners third-party IT contributors so at the same time in the coming quarters we are still dedicated to further upgrade our content ecosystem by further investing in this area. So we believe there's still significant potential in further increasing the average reading time or spending time on our platform for our Fundo Novo users, in particular for our existing users. And at the same time, as you have seen, we are continuing to invest in the user-user acquisition. In relation to the key data guidance, So you have seen that after the pandemic in Q1 2020 in China, between March and October 2020, the DA use of Hongdu novel has continued to increase from 7 million to 10 million. And in particular, the user retention rate and also the long-term user retention rate has improved rapidly. The seven days user retention rate increased by about 12%. The 30 days user retention rate increased by about 10%, and the 60 days user retention rate increased by about 7%. So it is all in a very good direction in relation to further increasing our user stickiness. On the output side, it was slightly higher during the pandemic period in China, in Q1 this year, given there is longer user spending time during the lockdown period, and also due to our continuous efforts in improving the user experience by limiting a certain kind of app strategy, is that we have slightly lower, recorded slightly lower Apple in Q2 and Q3 this year compared to Q1. this year. But we still believe that the ARPU will start to regain the growth momentum in the coming quarters with, first of all, the diversification of our revenue stream on the Fondue platform and also the improvement of our overall advertising strategy. For 2021, our target for the DAUs will still be a high growth, so up to 60% to 70% growth compared to the DAUs at the current level. And also we aim to deliver, obviously, higher R pool, returning to or even higher level compared to the Q1 pandemic period, and also the continuous improvement in the user retention rates with 30-day retention rates and 60-day retention rates. aiming at delivering continuously competitive levels in the coming quarters. Thank you.

Thank you.

This concludes our question and answer session. I would like to turn the conference back over to Jessie, Jim, for any closing remarks.

Okay. Thank you, operator. In closing, on behalf of the entire management team of Quotex, we'd like to thank you again for joining this conference call tonight. If you have any further inquiries in the future, please feel free to contact us at ir.cootech.com or cootech.icaasia.com. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.